What is Defeasance in a Commercial Mortgage?

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Are you a commercial property owner or investor looking to understand the ins and outs of defeasance in a commercial mortgage? Defeasance is a crucial concept to grasp in the world of commercial real estate financing. In this article, we will explore the meaning, process, and benefits of defeasance, shedding light on this important aspect of commercial mortgages.

Defeasance: Meaning and Definition

Defeasance, in the context of commercial mortgages, refers to the process of releasing a property from mortgage debt. It involves substituting the original collateral, typically the property itself, with a portfolio of government securities. This allows the borrower to satisfy the mortgage obligation without actually paying off the loan. Essentially, defeasance provides an alternative method for borrowers to retire their debt obligations.

The Process of Defeasance

To better understand how defeasance works, let’s walk through the process step by step. First, the borrower looking to defease their commercial mortgage engages a third-party defeasance consultant. This consultant acts as an intermediary between the borrower and lender, guiding them through the defeasance transaction.

Next, the borrower establishes a “defeasance escrow” account, into which they deposit funds sufficient to purchase the portfolio of government securities. These securities are carefully selected to match the remaining mortgage payments and are held in the escrow account until the mortgage is fully satisfied.

Once the securities are purchased, the borrower transfers them to a third-party custodian who will manage the portfolio on behalf of the lender. The custodian ensures that the mortgage payments are made promptly and in full until the loan term concludes.

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Benefits of Defeasance in a Commercial Mortgage

Defeasance offers several benefits for commercial property owners and investors. Firstly, it provides flexibility in financing options. By defeasing a mortgage, borrowers can retain ownership of their property while freeing up capital for other investments or expansion opportunities. This option proves especially valuable in cases where selling the property is not an ideal solution.

Secondly, defeasance can result in cost savings and tax benefits. As borrowers replace their mortgage with a portfolio of government securities, they may experience lower interest rates, reducing their overall financial burden. Additionally, defeasance can have tax advantages, as the borrower avoids triggering potential tax consequences associated with the sale of the property.

Frequently Asked Questions (FAQ) about Defeasance in Commercial Mortgages

Q: What are the fees associated with defeasance?
A: Defeasance typically incurs fees such as legal costs, third-party consulting fees, and transaction expenses. These fees may vary depending on the complexity of the transaction and the parties involved.

Q: How long does the defeasance process usually take?
A: The duration of the defeasance process can vary, but on average, it takes around 45 to 60 days to complete. Factors such as the complexity of the mortgage, coordination between parties, and the efficiency of document preparation can influence the timeline.

Q: Can any commercial mortgage be defeased?
A: Defeasance is generally applicable to fixed-rate commercial mortgages. Adjustable-rate mortgages or loans with specific prepayment penalties may have different terms and conditions related to defeasance. It is advisable to consult with a defeasance consultant or legal professional to assess the feasibility of defeasance for a specific mortgage.

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In conclusion, defeasance is a significant aspect of commercial mortgages that offers property owners and investors an alternative method to release themselves from mortgage debt. By substituting the collateral with a portfolio of government securities, borrowers can retain ownership of their property, enjoy flexibility in financing options, and potentially save on costs and taxes. Understanding the intricacies of defeasance is essential for commercial property owners and investors seeking to maximize their financial strategies in the realm of commercial real estate. Consultation with experienced professionals can provide further guidance and ensure proper execution of defeasance transactions.

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